Corporate venture capital on the rise
Looking back, 2013 has been the year of corporate venture capital (CVC). Corporate venture capital is a special form of investment of corporate funds directly in external target start-up companies. Corporations decide to pursue CVC projects not only for financial reasons, but also to create a ‘window on technology’, which enables them to early spot and follow innovations.
Corporations have realized that pumping millions of dollars into R&D projects might not be the best way to keep pace in their industries. The fall of tech giants like Kodak and Nokia, who did not sense the winds of innovation, are evidence of the failure of traditional R&D investment. Nowadays, there is another way for corporations to innovate and generate profits at the same time – by becoming active participants in the startup game.
2013 corporate venture capital in numbers
In 2013 corporate venture capital was on the rise. While the aftermath of financial crisis forced traditional venture capital investors to look twice at every penny, the money purses of tech and healthcare companies have been getting heavier every day. Cbinsights reports that in 2013, corporations participated in nearly 40% of the top 100 venture capital tech deals and in 25% of overall venture capital funding.
The scale and magnitude of CVC deals is usually different from typical VC deals. Thanks to favorable figures on the balance sheets and unique know-how supporting the deal, CVC deals are 60% larger than typical VC deals. Major tech and healthcare corporations like Google, Intel, SAP, Novartis or Johnson & Johnson top the list of the most active CVC investors.
Strategic and financial motivations for corporate venture capital
As Henry W. Chesbrough, Professor at Haas School of Business, University of California, Berkeley explains, corporate venture capital has two investments objectives.
The first, so called strategic objective, is to increase the sales and profits of the corporation’s own businesses. For instance, Johnson & Johnson Development Corporation invests in new ventures, usually biotech related, aligned with business strategies of the Johnson & Johnson family of companies. It means that the corporation indirectly creates a friendly environment for its own products.
The second investment objective is financial and focuses predominantly on generating profits for the corporation. Here, the main reason why a corporation decides to dive into CVC is not a strategic expansion, but rather an expectation of revenues on investment. A good example of such CVC is Google Ventures. Its model is simple: Google injects it with money, Google Ventures independently invests it in good ideas and in the end Google collects the profits. Unlike Johnson & Johnson Development Corporation, it does not only invest in the fields that might be regarded as strategic for Google. Instead, it has supported start-ups in a wide range of industries, from life science & health sector, like 23andMe to commerce or mobile, like Uber. Every corporation, thanks to its unique plot of experiences, products and industries it operates in, is motivated by different reasons to pursue CVC.
Quick response to market transformations
In a fast-developing world full of disruptive technologies staying innovative is not an easy task. Thus, corporations use CVC as a handy alternative to conventional R&D departments, which do not always do a great job of spotting and responding to competitive threats. Last decade provides many examples of futile use of R&D.
When Kodak’s management failed to grasp the changes happening in the digital photography by hoping that new technologies will simply fade away, it ended up declaring bankruptcy. Similarly, Nokia missed the smartphone wave by focusing primarily on strengthening its leader position in the low-end phone market. In the end, Microsoft decided to acquire the former phone-manufacturing giant. Could these scenarios have been handled differently? Yes, potentially by starting CVC projects.
CVC investments into emerging ventures help corporations gather strategic information at relatively low cost. Thanks to them, corporations can access new, disruptive technologies in a quick and easy way. Instead of building new processes or products from scratch, corporations can invest in a start-up and have access to the whole package. They do not have to spend long hours to update their research laboratories or recruit scientists and engineers with the right expertise. Ideas, disruptive visions, devoted experts – it all already comes with a start-up. Thus, a corporation only has to provide a financial injection. Start-ups will know what to do with the money.
Break-ups with a venture relationship are relatively easy
Another benefit of CVC is that it allows for easier disengagement from unsuccessful ventures. No one likes to admit to a defeat, especially when a corporation has already invested millions of dollars into developing its new product line, which later proved a total disaster. In such scenario, decision to abandon a disastrous internal project is never easy. However, thanks to CVC a corporation may part with the venture and start looking for new investments. When there are other funders involved, who might be pushing towards exit, a decision to disengage from an unsuccessful start-up might be even easier.
CVC is a great opportunity for resourceful corporations to stay competitive and to quickly grasp upcoming changes to the industries they operate in. One of the underlying economic principles provides that everyone wants to make the best use out of the resources they have. Engaging funds in new ventures is one of the ways to achieve this goal. So far, individual investors, VCs and university endowments have dominated the startup game. CVC investing has already begun to transform the VC market and will likely continue to do so as the calendar turns from 2013 to 2014.